G ra d e Le ve l

High School
page 1
Author
John S. Morton Senior Program Officer, Arizona Council on Economic Education

Price Ceilings and Price Floors

Classroom lesson aligned to the Arizona Social Studies Articulated Standards in Economics (Strand 5). The lesson is designed so it can be accomplished within one class period.

Strand Five: Arizona Economics Standard

Concept 2: Microeconomics. PO 2. Describe how markets function: a. laws of supply and demand b. how a market price is determined c. how price ceilings and floors cause shortages or surpluses

Related Mathematics Standards

Strand 2: Data Analysis, Probability, and Discrete Mathematics Strand 4: Geometry and Measurement Strand 5: Structure and Logic - Reasoning and Problem Solving

Concepts
Equilibrium Price The price at which the quantity demanded by buyers equals the quantity supplied by sellers; also called the market-clearing price. ______________________________________________________________________ Equilibrium Quantity The quantity demanded and the quantity supplied at the equilibrium or market-clearing price. ______________________________________________________________________ Price Ceiling A legally established maximum price that must be charged for a good or service. ______________________________________________________________________ Price Floor A legally established minimum price that must be charged for a good or service. ______________________________________________________________________ Quantity Demanded The amount of a good or service that people will buy at a given price in a given period of time. ______________________________________________________________________ Quantity Supplied The amount of a good or service that sellers are willing and able to offer at a given price in a given period of time. ______________________________________________________________________ Shortage The situation that results when the quantity demanded of a product exceeds the quantity supplied. Generally, this happens because the price of the product is below the equilibrium price. ______________________________________________________________________ Surplus The situation that results when the quantity supplied of a product exceeds the quantity demanded. Generally, this happens because the price of the product is above the equilibrium price. ______________________________________________________________________ Wage Payments for labor services that are directly tied to time worked or to the number of units of output produced.

Overview
This lesson is an introduction to the study of price ceilings and price floors. It should be used after the students have learned the fundamentals of supply and demand analysis. The students learn what price ceilings and price floors are and how they cause shortages or surpluses. Finally, they apply these concepts to case studies of Arizona laws and potential laws.

This Lesson Underwritten by a Grant From: Toyota Foundation USA

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G ra d e Le ve l

High School
page 2 Price Ceilings and Price Floors
Objectives
1. Describe how an equilibrium price is determined. 2. Define and describe the effects of price ceilings and price floors. 3. Analyze public policies using the concepts of price ceilings and price floors.

Lesson Procedure
1. Review supply and demand analysis with the class using a standard graph of supply, demand, and equilibrium. Give particular emphasis to why a market reaches an equilibrium price and quantity. If the initial price is above equilibrium, there is a temporary surplus, which causes the price to decrease, which increases the quantity demanded and decreases the quantity supplied until the price reaches equilibrium. If the initial price is below equilibrium, there is a temporary shortage, which causes the price to increase, which decreases the quantity demanded and increases the quantity supplied until the price reaches equilibrium. Only at the equilibrium price does the quantity demanded equal the quantity supplied. 2. Ask the students:If the government imposed a price below the equilibrium price, what would happen? (There would be a shortage.) Explain that this is called a price ceiling. A price ceiling is a legally established maximum price that sellers must charge for a good or service. 3. Now ask the students:If the government imposed a price above the equilibrium price, what would happen? (There would be a surplus.) Explain that this is called a price floor. A price floor is a legally established minimum price that sellers must charge for a good or service. 4. Distribute a copy of Handout 1 to each student. Ask the students to read the handout and answer the questions at the end. 5. Discuss the answers to the questions with the class. A. Why do price ceilings cause shortages? (The mandated lower price increases the quantity demanded and decreases the quantity supplied. The difference is a shortage. Use Figure 1 to illustrate this.) B. Why do price floors cause surpluses? (The mandated higher price decreases the quantity demanded and increases the quantity supplied. The difference is a surplus. Use Figure 1 to illustrate this.) C. Why does a price ceiling set above the equilibrium price not cause a shortage? (The market will clear at the equilibrium price before the price ceiling has an effect. The same thing will happen if the price floor is set below the equilibrium price. Politicians sometimes set price ceilings above equilibrium and price floors below equilibrium so they look good to special interests without actually affecting the market.)

This Lesson Underwritten by a Grant From: Toyota Foundation USA

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G ra d e Le ve l

High School
page 3 Price Ceilings and Price Floors
D. Arizona voters passed a law mandating that employers may not pay their employees less than the minimum wage. The exact minimum wage depends on the cost of living and other factors. In 2009, Arizonas minimum wage was $7.25 per hour. 1) Is this a price ceiling or price floor? (Price floor. A wage is the price of labor. The law prohibits a wage lower than $7.25 per hour.) 2) Describe the effects of this law on employment in the state. Who is hurt and who is helped? (The minimum wage will decrease the quantity demanded for low-skilled workers. Workers who earn more than the minimum wage are not affected. More highly-skilled teenagers who are considered more productive may be helped as they displace lower-skilled adult workers. Low-income people bear a disproportionate burden of the job loss. A study by Florida State University professor David Macpherson [Employment Policies Institute, 2009] estimates that 70 percent of the benefits of the Arizona minimum wage goes to families above the poverty line and 37 percent of the job losses goes to families earning under $25,000 per year.) 3) Draw a graph that illustrates the effects of this law.

Wage $

Number of Workers

Key: Price Floor Demand Supply

E. Imagine that you are an economist who advises members of the state legislature on economic issues. A state senator asks you to predict what would happen if Arizona were to limit the interest rate lenders may charge for a loan. Such a law is called a usury law. 1) Is this a price ceiling or price floor? (Price ceiling. An interest rate is the price of money. The proposed law mandates the maximum interest rate that lenders may charge.) 2) Describe the effects of this law on lending in the state. Who would be hurt and who would be helped? (Fewer loans would be available. The law would particularly hurt people with lower credit ratings because they could no longer get a loan by paying a higher interest rate. Lenders that specialize in high-interest loans to people with poor credit ratings would be hurt.) 3) Draw a graph that illustrates the effects of this proposed law.

Interest Rate

Quantity of Loans

Key: Price Floor Demand Supply

This Lesson Underwritten by a Grant From: Toyota Foundation USA

www.azecon.org

G ra d e Le ve l

High School
page 4 Price Ceilings and Price Floors
Closure
Discuss with the students various price ceilings and price floors such as: Minimum wage (Price floor) Crop price supports (Price floor) Rent control (Price ceiling) Wage and price controls (Price ceiling) Price control on gasoline (Price ceiling) Usury laws (Price ceiling)

Additional Recommended Lessons

Where Did the Mortgages Go? The Great Economic Mystery Book: A Guide to Teaching Economic Reasoning, Grades 9-12, National Council on Economic Education The Urban Housing Mystery, The Great Economic Mystery Book: A Guide to Teaching Economic Reasoning, Grades 9-12, National Council on Economic Education Unit 2, Lesson 14,Secondary Effects: Price Ceilings and Floors, Capstone: Exemplary Lessons for High School Economics, National Council on Economic Education

This Lesson Underwritten by a Grant From: Toyota Foundation USA

www.azecon.org

G ra d e Le ve l

High School
handout 1 - pg. 1 Price Ceilings and Price Floors
Directions: Read the following essay, and answer the questions at the end. In a market economy, prices send signals which provide information to buyers and sellers. When supply or demand changes, the market prices of goods and services change. Higher prices provide incentives for sellers to produce more and buyers to buy less. Lower prices provide incentives for sellers to produce less and buyers to buy more. Eventually, the market reaches a new equilibrium price where the quantity demanded equals the quantity supplied. The invisible hand of the market determines a price where the quantity supplied is equal to the quantity demanded. Just the right amount of the good or service is produced by sellers to satisfy consumers. Government Price Controls Governments sometimes interfere with the market. In a democracy, the politicians do this to keep certain voters happy. However, government-mandated price controls end up causing shortages or surpluses in the market. One type of government price controls is a mandated maximum price. This is called a price ceiling because it is illegal for any seller to sell at a price above the mandated price ceiling. Price ceilings, such as rent control, cause shortages. Another type of price controls is a price floor, which is a mandated minimum price. It is illegal for any seller to sell at a price below the mandated price floor. No bargain-basement prices are allowed. Price floors, such as price supports for agricultural products, cause surpluses. Figure 1 is a graph that illustrates why price ceilings cause shortages and price floors cause surpluses.
Supply

$10

Figure 1
Price of Hamburgers $8 Pf Price Floor

$6

Pe

$4

Pc

Price Ceiling

$2 Demand 10 20 30 40 50

Quantity of Hamburgers

Figure 1 shows the supply and demand schedules for hamburgers. Without any government-mandated price controls, the equilibrium price for hamburgers is $6, and the equilibrium quantity exchanged is 30.

This Lesson Underwritten by a Grant From: Toyota Foundation USA

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G ra d e Le ve l

High School
handout 1 - pg. 2 Price Ceilings and Price Floors
A Price Ceiling Assume the government passes a law mandating a price ceiling of $4. No one may buy or sell hamburgers above a price of $4. Now the quantity supplied of hamburgers is 20, and the quantity demanded is 40. There is a shortage of 20 hamburgers. Who will receive the 20 hamburgers that are produced? People could stand in line, use a lottery, or perhaps get coupons from the government. Some people may act illegally and offer bribes to sellers. Politicians might make sure their supporters get the hamburgers. The most common price ceiling in the United States is rent control. In some cities, rents are not allowed to go above a certain price. This results in housing shortages, bribes to landlords, and landlords not maintaining their rental units. Because of these problems, most rent-control laws have been repealed. A Price Floor Now assume the government passes a law imposing a price floor of $8. At $8, the quantity demanded of hamburgers is 20, and the quantity supplied is 40. Now there is a surplus of 20 hamburgers. What will happen to the surplus of 20 hamburgers? They might spoil and be thrown out, or perhaps the government will buy them from the sellers. In fact, the government does this for several types of farm products. Thats why you get cheap cheese in your school cafeteria. The government has a price floor on milk. It then buys the surplus milk and turns it into cheese. The cheese surplus is sent to schools at the expense of taxpayers. The Cost of Price Controls Governments impose price controls to help either buyers or sellers without having to pay a cost. However, some people gain and some people lose whenever a price ceiling or price floor is mandated by a government. Most importantly, price controls harm the ability of markets to produce and consume efficiently.

Questions
A. Why do price ceilings cause shortages? __________________________________________________________ ________________________________________________________________________________________ B. Why do price floors cause surpluses? ____________________________________________________________ ________________________________________________________________________________________ C. Why does a price ceiling set above the equilibrium price not cause a shortage? ______________________

________________________________________________________________________________________ D. Arizona voters passed a law mandating that employers may not pay their employees less than the minimum wage. The exact minimum wage depends on the cost of living and other factors. In 2009, Arizonas minimum wage was $7.25 per hour. 1) Is this a price ceiling or price floor? __________ 2) Describe the effects of this law on employment in the state. Who is hurt and who is helped? ______________________________________________________________________________________ ______________________________________________________________________________________ This Lesson Underwritten by a Grant From: Toyota Foundation USA www.azecon.org

G ra d e Le ve l

High School
handout 1 - pg. 3 Price Ceilings and Price Floors
3) Draw a graph that illustrates the effects of this law.

E. Imagine that you are an economist who advises members of the state legislature on economic issues. A state senator asks you to predict what would happen if Arizona were to limit the interest rate lenders may charge for a loan. Such a law is called a usury law. 1) Is this a price ceiling or price floor? __________ 2) Describe the effects of this law on lending in the state. Who would be hurt and who would be helped? ______________________________________________________________________________________ ______________________________________________________________________________________

3) Draw a graph that illustrates the effects of this proposed law.

This Lesson Underwritten by a Grant From: Toyota Foundation USA

www.azecon.org